Call Options Or Put Options On Southwest Airlines (LUV)?

| May 23, 2012 | 0 Comments

LUV OptionsSouthwest Airlines (LUV) is a low-fare major domestic airline.  Their business is offering low-fares, reliable flights, and exemplary customer service.

Southwest is the nation’s largest carrier in terms of originating domestic passengers boarded serving 73 cities in 38 states.  They’re one of the most honored airlines in the world for their commitment to the triple bottom line of Performance, People, and Planet.

LUV currently trades for $8.13 per share.  In the last year, LUV is down about 33% from its 52-week high of $12.25.  But it’s shown some strength recently as it rallied 14% from the 52-week low of $7.14.

Southwest Airlines Chart 052312

Is this an opportunity to buy call options on LUV before it surges higher?   Or is this the time to buy put options on LUV as it falls back to its lows?

The bulls make a convincing argument…

The combination of falling jet fuel prices and high travel demand should boost LUV’s profitability.

As you know, oil prices have tumbled lately.  The cost of a barrel of West Texas Intermediate crude oil has fallen from $110 in February to around $90 today.

And jet fuel prices are falling right along with crude oil prices. In fact, jet fuel prices have fallen 8% since the beginning of May.

Make no mistake, this is a huge development for Southwest.

It’s estimated that fuel costs account for more than 34% of Airline operating costs.  So anytime fuel prices fall it has a big impact on the bottom line.

What’s more, total passenger demand for airline seats has been growing faster than the supply of new seats.  That’s led to higher prices for a seat on Southwest and across the industry.

And demand is expected to be strong as we go into the summer travel season.  And that’s a combination that could fuel a big rally in LUV.

But the bears have a compelling case as well… 

Despite the appearance of strong fundamentals, airlines are simple bad investments.

First off, they operate in a highly competitive market.

Lately airlines have been playing nice.  But an airfare war could pop up at any moment.  If one airline start undercutting the others’ prices to gain market share, we could see profitability evaporate in an instant.

They also have huge expenses that they can’t control.

Their unionized employees seem to demand more pay anytime airlines start to make any money.  So even if Southwest increases revenue, their employees will likely demand they get paid more before it ever reaches the shareholders.

And even though fuel costs have been falling, there’s no guarantee they’ll stay down for long.  And when fuel accounts for more than 30% of expenses, rising oil prices will stop a rally in airline stocks dead in it tracks.

Obviously with headwinds like these, rallies will be short lived.  And if oil prices surge, Southwest and the entire airline industry is likely heading lower.

If you think the bulls are right, take a look at buying the LUV September 2012 $9 Call for around $0.35. 

If you think the bears are right, take a look at buying the LUV September 2012 $8 Put for around $0.60.

Good Investing,

Corey Williams

Tags: , , , ,

Category: Call Or Put Options?

About the Author ()

A former banking executive, Corey Williams is the Chief Options Strategist and co-editor of our well-known daily newsletter, Options Trading Research. Corey’s extensive experience with options goes all the way back to his days in corporate finance. It was this decade in banking where Corey discovered the most important skill an options trader can have– the ability to analyze a company or sector to determine its likely future direction. And now he’s brought this background, experience and love of options to Options Trading Research, the unique daily e-letter devoted exclusively to helping individual investors profit from the very lucrative options market.